Limitations in Project Chittagong

Case and Spartans Inc. Case

Submitted to
Dr. Md. Rezaul Kabir
Associate Professor
IBA, University of Dhaka

Submitted by
Roll 007 - Abu Zafar Md. Saleh
Roll 009 - Musarrat Hossain Mariha
Roll 058 - Md. Rabib Al Rafayed
Roll 073 - Faiza Kamal
Roll 109 - Tahnaaz Ayub
Roll 113 - Shyam Ahmed

Date: 28th March, 2020

 Limitations of Project Chittagong Case
Limitation 1: Absence of depreciation value after year 20
Project Chittagong is assumed to have an infinite lifetime. However, the depreciation value
for the project is available for only the first 20 years. The unavailability of depreciation after
the 20th year will impact the accuracy of the cash flow of the project, which is a flaw of the
case.
To maintain similar productivity for an infinite period the project will require sustaining
capital expenditure for an infinite period. In this case, the sustaining capital expenditure
equals the annual depreciation. It is expected to change according to the change in
depreciation after Year 20. As the depreciation value is only provided for the first 20 years, it
will create a problem in calculating proper sustaining capital expenditure after Year 20.

Limitation 2: Ignoring asset types in calculating depreciation

In the case, it is assumed that all the assets in the business will be depreciated over 20 years
in a single method which is not mentioned. However, the initial investment might be used
for multiple assets with different characteristics, and with different lifetimes. Moreover,
different assets might require different depreciation methods for proper depreciation. The
lack of information regarding the asset types and depreciation methods are a limitation of
the case.

Limitation 3: Not considering the principal payment of the debt

Project Chittagong uses a 10 year, 30 billion BDT bank loan with a 5% before tax interest
rate. In the capital budgeting calculation, only the interest payment portion of the loan
repayment is considered but repayment of the loan principal is not calculated.

Limitation 4: Considering Weighted Average Cost of Capital to be Fixed

Project Chittagong has a fixed weighted average cost of capital of 8.5%. It is assumed that
the project will have a similar required rate of return for an infinite period with the same
capital structure. However, in the future, the cost of capital might change due to new debts
with different interest rates or increased required rate of return of the equity due to change
in market risk, risk-free rate and opportunity cost. The capital structure can also face change
due to new debts or increased equity. Ignoring the possibility of change in weighted average
cost of capital and capital structure is a limitation of the case.

Limitation 5: Assuming similar revenue and cash flow from year 05

The case assumes that the sales revenue will have zero growth rate after year five. But the
project will exist for an infinite period. In this infinite period, the product price will face
inflation or deflation based on the market scenario. This inflation or deflation will cause a
change in the revenue of the project. Here in the case, the change in revenue due to the
inflation or deflation of the product price is ignored which is a limitation of the case.
Moreover, in the long run the demand for the product, production capability, the cost of
production and tax rate might change due to changes in the economy, industry, the market,
government policies, and due to the entrance of new competition. These changes will result
in a change in the profitability and cash flow of the project. So the unchanged cash flow for
an infinite period is a limitation of the case.

Limitation 6: Ignoring foreign exchange conversion and foreign exchange risk

in the initial investment and repatriation of the profit
Huawei is a Foreign Company. But the investment is made in Bangladesh and all cash flows
are calculated in Bangladeshi Taka. The project has equity investments which might include
a foreign direct investment from Huawei in a different currency. Moreover, Huawei might
want to repatriate the complete profit or a portion of profit to the home country. In this
case, the exchange rate between Bangladeshi Taka and the home country currency of
Huawei will impact the actual free cash flow. This will also create an exchange rate risk due
to the change in the exchange rate in the long term. In the case, the impact of currency
exchange and exchange rate risk is ignored which is a limitation of the case.
 Limitations of Spartan Inc. Case

Limitation 1: Absence of initial investment breakdown for capital

expenditure and working capital

The case only provides the Initial Investment of the project which is estimated to be BDT
20,000,000. The investment includes both capital expenditure in Plant and Equipment and
initial working capital. But how much of the initial investment will be used as capital
expenditure or working capital is not given in the case. Without these values, getting the
accurate free cash flow in Year 4 is not possible.
In Year 4, Spartans' free cash flow will be impacted by its working capital, which is not
available in the case. Moreover, it is mentioned in the case that the annual depreciation
value is BDT 2,000,000. The salvage value of the assets will be 15,000,000 at the end of the
4th year and Spartan will have to pay 15% capital gain tax. To calculate the salvage value
after capital gain tax, the initial investment in plant and equipment is necessary as different
initial investments will result in different salvage value after Capital Gain Tax. This is
exhibited in Table 01:

Table 01: Change in Salvage value after capital gain tax based on the change in the
initial investment in plant and equipment.

Limitation 2: Change in the working capital throughout the 4 years is not

available
The initial working capital of the project and the change in working capital in the next 4
years is not available in the case. The sales price, volume, and variable costs change over the
period. So there is a chance that the working capital will also change throughout these 4
years. However, these changes are not available in the case which is a big limitation of the
case.

Limitation 3: Exchange rate is forecasted to be fixed

In the case, the exchange rate between the U.S. Dollar and Bangladeshi Taka is forecasted to
be 0.45 USD per BDT for all future periods. Although in the managed floating exchange rate
in Bangladesh, the exchange rate is expected to fluctuate throughout the period which will
create exchange rate risk and ensure changes in the cash flow to the parent company.
However, in the case, these scenarios are not considered by using a fixed exchange rate for
the long term.

Limitation 4: Opportunity of Using Domestic Financing is Ignored

The project is completely equity financed using the foreign investment of the parent
company at a 15% required rate of return. However, the case doesn't consider using
domestic financial sources to fund a portion of the project. Using domestic sources like
debt, Spartan can ensure a lower required rate of return and exchange rate risk. They can
also use the domestic debt sources to leverage the return generated from the investment.
Avoiding these opportunities can be considered as a limitation of the case.
Limitation 5: Weighted Average Cost of Capital is fixed
The project has a fixed weighted average cost of capital which is 15% the required rate of
return of the equity fund provided by the parent company. But in the 4 year period the
required rate of return can change due to the change of market risk, risk free rate and
opportunity cost of the project. Moreover, Spartan can finance money from domestic
sources which will change the capital structure of the project and subsequently change the
weighted average cost of capital. So ignoring the possibility of change in weighted average
cost of capital and capital structure is a limitation of the case.

Limitation 6: Opportunity Cost of Investing in the Domestic Market

All the free flow from the project is repatriated to the parent country. But the free cash flow
can also be invested in Bangladeshi market and it creates an opportunity cost for the
Spartan. This opportunity cost is ignored in the case which is a limitation of the case.